Welfare Migration: Is the Net Fiscal Burden a Good Measure of its Economics Impact on the Welfare of the Native-Born Population?

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An electronic version of the paper may be downloaded

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CESifo

Working Paper No. 1273

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Abstract

Migration of young workers (as distinct from retirees), even when driven in by the generosity

of the welfare state, slows down the trend of increasing dependency ratio. But, even though

low-skill migration improves the dependency ratio, it nevertheless burdens the welfare state.

Recent studies by Smith and Edmonston (1977), and Sinn et al (2003) comprehensively

estimate the fiscal burden that low-skill migration imposes on the fiscal system. However, an

important message of this paper is that in an infinite-horizon set-up, one cannot fully grasp the

implications of migration for the welfare state just by looking at the net fiscal burden that

migrants impose on the fiscal system. In an infinite-horizon, overlapping generations

economy, this net burden could change to net gain to the native-born population.

JEL classification: H0.

Keywords: migration, welfare state, fiscal burden.

Assaf Razin

Tel Aviv University

Economics Department

69978 Tel Aviv

Israel

[email protected]

Efraim Sadka

Tel Aviv University

The Eitan Berglas School of Economics

Naftali Building

69978 Tel-Aviv

Israel

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2 Introduction

Following its recent and forthcoming enlargements, the European Union is likely to face a rise in welfare migration. Hans-Werner Sinn (Financial Times, July 12th, 2004) puts this issue succinctly:

“There will be more migration in Europe, but it will be ‘bad’ migration as well as ‘good’. ‘Good’ migration is driven by wage and productivity diﬀerence. ‘Bad’ migration is driven by the generosity of the welfare state."

Indeed, we demonstrated elsewhere that the generosity of the welfare state, as by itself, drives out high-skill migration and drives in low-skill migration (see Razin and Sadka (2001, forthcoming)).

Europe, both “old" and “new", faces also a severe aging problem. This shakes the

financial soundness of the welfare state, especially its old-age security and medical health components, because there are fewer workers asked to support increasing numbers of

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re-tirees (that is, the dependency ratio rises).1_{As put metaphorically by the Economist (March}

15th, 2003, p.80):...“thefiscal burden on the diminishing number of worker-bees will rise as more people turn into pensioner drones." Note that migration of young workers (as distinct from retirees), even when driven in by the generosity of the welfare state, slows down the trend of increasing dependency ratio. However, intuition suggests that even though low-skill migration improves the dependency ratio, it nevertheless burdens the welfare state.2 This is because low-skill migrants are typically net beneficiaries of a generous welfare state. Indeed, in 1997 the U.S. National Research Council sponsored a study on the overallfiscal impact of immigration into the U.S.; see Smith and Edmonston (1997).3 The study looks carefully at all layers of government (federal, state, and local), all programs (benefits), and all types of taxes. For each cohort, defined by age of arrival to the U.S., the benefits (cash or in kind) received by migrants over their own lifetimes and the lifetimes of their

first-generation descendents were projected. These benefits include Medicare, Medicaid, Supplementary Security Income (SSI), Aid for Families with Dependent Children (AFDC), food stamps, Old Age, Survivors, and Disability Insurance (OASDI), etc. Similarly, taxes paid directly by migrants and the incidence on migrants of other taxes (such as corporate taxes) were also projected for the lifetimes of the migrants and their first-generation de-scendents. Accordingly, the netfiscal burden was projected and discounted to the present. In this way, the netfiscal burden for each age cohort of migrants was calculated in present-value terms. Within each age cohort, these calculations were disaggregated according to three educational levels: Less than high school education, high school education, and more than high school education. Thefindings suggest that migrants with less than high school

1_{In Razin and Sadka (forthcoming) we provide a political-economy analysis of the e}_ﬀ_{ect of this aging on} the welfare state.

2_{Simon (1984) is one of the}_fi_{rst studies that brought out this argument.}

3_{Responding to concerns in the U.S. (with foreign-born population of roughly 11.5 percent) about the}

eﬀect of immigration on the economic prospects of native-born, Congress in 1990 appointed a bipartisan Commission on Immigration Reform to review the nation’s policies and laws and to recommend changes. In turn, in 1995 the commission asked the National Research Council to convene a panel of experts to assess the demographic, economic, andfiscal consequences of immigration.

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education are typically a netfiscal burden that can reach as high as approximately $100,000 in present value, when the migrants’ age on arrival is between 20-30 years.4

Similarly, a comprehensive study by the IFO Institute estimated the flows of state benefits to the stock of immigrants in Germany in 1997. Account was taken of taxes, contributions, pensions, welfare benefits as well as all indirect benefits from so-called public goods; see Sinn et al (2001).5 The findings suggest, for instance, that a migrant family with three children that came to Germany in 1997 and stays for ten years, receives anet

benefit totalling about 120,000 euros.

Indeed, the net fiscal eﬀect of the unskilled migrating generation is usually negative. However, in evaluating benefits of low-skill migration to the current (as well as the future) native-born population, it is important to assess the very long-term eﬀect of this migration on thefiscal system. One has to take into account theinfinite horizonof theeconomy, as distinct from the finite lives of its individuals. When the migrants’ descendents grad-ually integrate into the economy, the current native-born population (both workers and

retirees), as well as all future generation, may well gain from low-skill migration.

3 The Infinite-Horizon Argument

Consider an overlapping-generations model, where each generation lives for two periods.6 In each period a new generation with a continuum of individuals is born. Each individual possesses a one unit of labor-schooling time endowment in the first period, when young. There is a pay-as-you-go (PAYG) pension system, which employs payroll taxes (at a flat rate t) on the working young in order tofinance a uniform benefit (b) to the aged.

4_{See also Auerbach and Oreopoulos (1999) for a further analysis of these}_fi_{ndings. Storesletten (2000)} calibrated a general-equilibrium, overlapping generations model to capture the eﬀects of inflows of working-age immigrants to the U.S. on thefiscal system, taking into account changes in factor prices.

5

Thefindings are also summarized in Table 1 of Sinn (forthcoming). Obviously, pure public goods, such as defense, are not included in the calculations, because immigrants consumption of the services of these goods do not reduce consumption of native born.

6_{We sketch here only the backbones of the analytical framework behind the in}_fi_{nite-horizon argument.} A detailed derivation of equations (1)-(4) is contained in Razin and Sadka (1999).

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There are two levels of labor productivity: an unskilled worker with low productivity and a skilled worker with high productivity. A skilled worker provides an effective labor supply of one unit, per units of time at work; while an unskilled worker provides only q<1 units of effective labor supply, per units of time at work. The wage per effective units of labor is denoted by w.

Born unskilled, each individual can nevertheless acquire skills, and become a skilled worker, by investing e units of time in schooling, in thefirst period. The remainder of her time, 1-e, is spent at work as a skilled worker. The individual-specific parameter e reflects the innate ability of an individual in acquiring a work skill. The lower is e, that is the less time she needs to acquire the skill, the more able is the individual. The parameter e ranges between 0 and 1, with a cumulative distribution function, G(e), describing the heterogeneity of the population concerning the cost-of-acquiring-skill parameter e.

In the first period of her life the individual brings 1+n children, decides whether to acquire skill, works, consumes, and saves for retirement in the second period. In the second period she only consumes her retirement saving and pension.

One can show that all individuals with cost-of-education parameter below e* = 1-q will acquire skill, whereas all the rest will remain unskilled.

Suppose that at some period (say, period zero), a one-shot wave of m unskilled, working age, migrants are allowed in. They grow up at the same rate (n) as the native-born popu-lation, and the ability index of the oﬀspring, who have access to the same education system as the native born is distributed similarly according to the same cumulative distribution function G. That is, the second generation of the immigrant wave are fully integrated into the society. In fact this assumption, together with the infinite horizon of the economy and the PAYG nature of the pension system, are the driving forces behind our argument.

Consider now the following thought experiment. Suppose that the government contin-ues to maintain the pre-migration social security contribution rate, t, intact. We then ask what pension benefit can be paid to retirees in our PAYG system. One can show that

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the pension that will be paid to the old, living when the wave of unskilled, working age migration takes place (i.e., period 0), is:

b0 = (1 +n)tw    e∗ Z 0 (1₋e)dG(e) +q[1₋G(e_∗) +m]   , (1)

whereas the pension paid to all future generations is:

b1 =b2 =b3 =...= (1 +n)tw    e∗ Z 0 (1₋e)dG(e) +q[1₋G(e_∗)]   . (2)

Upon inspection of equation (1), one can observe thatb0, the pension benefit to retirees

at the period when the migrants wave takes place, increases in the number of unskilled, working age, migrants. Therefore, as expected, the old generation in period 0 is clearly better-oﬀwith migration. Upon inspection of equation (2), one can observe thatb1 =b2 =

b3 = ..., the pension benefit to retirees in all post-migration periods, are unaﬀected by

the migration. In particular, and somewhat surprising, the young generation at the time in which unskilled, working age migration takes place (both the skilled and the unskilled native-born members) is not adversely aﬀected by the migration. Thus, the existing native-born population will welcome the unskilled, working age migration.

Furthermore, by creating some surplus in the pension system (to be invested in a social security fund) during the period of migration (that is, by loweringb0 towards, but not all

the way, to the pre-migration pension benefit) the gains that accrue only to the current old, could be spread out to the current young as well as to all future generations. In other words, unskilled, working age migration is aPareto-improving change with respect to migrants, as well as the existing current and future native born generations.

Strikingly, this result obtains even though the unskilled migrants may well be net beneficiaries of the redistributive pension system, in the sense that the present value of their pension benefits exceeds their pension contributions. To demonstrate this point, we calculate the present value of life-time netfiscal burden (NFB) of a representative unskilled migrant. This burden is:

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NFB = 1+₁₊n_rtw    e∗ Z 0 (1₋e)dG(e) +q[1₋G(e_∗)]   −tqw. (3)

One can see that the burden is positive if:

G(e∗)(e∗−_e) 1−e∗ >

r−n

1+n, (4)

where _e is the skilled population mean of the cost-of-education parameter. Note that

e_∗ >_e, because e* is the upper bound of the cost-of-education parameter of skilled indi-viduals, whereas_e is the corresponding mean. Thus, the left-hand side of (4) is definitely positive. Consider the plausible case where r >n, in which the economy is dynamically eﬃcient.7 _{If a large share of the native-born population is skilled, then condition (4) could}

be satisfied. In this case, NFB is positive at the same time that unskilled, working age migration is a Pareto-improving change for the migrants and the native-born populations. As expected (if the host country has a large number of skilled people), then when unskilled, working age migrants come to a country whose pension system redistributes income from the (skilled) rich to the (unskilled) poor, they impose a netfiscal burden. But what we have established is that even though migrants are net "consumers" of the pension system, all existing and future generations of the native-born population may gain from migration .

4 Conclusion

An important lesson that we draw here is that in an infinite-horizon set-up, one cannot fully grasp the implications of migration for the welfare state just by looking at the net

fiscal burden that migrants impose on thefiscal system. The studies by Sinnet al (2003), and Smith and Edmonston (1977), among others, properly emphasize the fiscal burden that low-skill migration imposes on the fiscal system. However, in an infinite-horizon, overlapping generations economy, this net burden is perfectly consistent with a net gain to

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the native born population. The additional obligation of thefiscal system to pay pension benefits to the incoming migrants, when they retire, could be shifted forward, in eﬀect, indefinitely. If, hypothetically, the world would come to a stop at a certain point of time in the future, the young generation at that point would bear the deferred cost of the present migration. But in an ever-lasting economy, the migrants, by supplying work and helping thefinancing the pension benefit of period zero to native born retirees, are a boon to the the host country population: old, young, and future generations.8

5 References

References

[1] Auerbach, Alan and Philip Oreopoulos, 1999. "Analyzing the Fiscal Impact of U.S. Immigration,"American Economic Review, Papers and Proceedings, 89 (May), 176-80.

[2] Razin, Assaf and Efraim Sadka, 1993.The Economy of Modern Israel: Malaise and Promise, University of Chicago Press.

[3] Razin, Assaf and Efraim Sadka, 1995. "Resisting Migration: Wage Rigidity and In-come Distribution,"American Economic Review, Papers and Proceedings, 85 (May), 312-316.

[4] Razin, Assaf and Efraim Sadka, 1999. "Migration and Pension with International Capital Mobility," Journal of Public Economics, 74, 141-150.

8_{Migration may have some other important implications that are not addressed here. Migration may}

exert a downward pressure on wages. If wages are rigid, then this may cause a rise in unemployment; see Sinn (forthcoming) and Razin and Sadka (1995). But if labor markets areflexible, the pressure may drive wages down; see storesletten (2000) and Razin and Sadka (2000). However, the decline in wages may well be just a short-term phenomena, as it triggers accummulation of new capital; through both domestic savings and international capital inflows. Indeed, the massive immigration into Israel from the former Soviet Union, following the collapse of communism, was met by a fairly flexible labor market, and a massive influx of capital; see Razin and Sadka (1993) for an early account.

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[5] Razin, Assaf and Efraim Sadka, 2000. "Unskilled Migration: A Burden or a Boon for the Welfare State," Scandinavian Journal of Economics, Vol. 1 (May), 463-479

[6] Razin, Assaf and Efraim Sadka, 2001. Labor, Capital, and Finance: Interna-tional Flows, Cambridge University Press.

[7] Razin, Assaf and Efraim Sadka, with the collaboration of Chang Woon Nam, forth-coming. The Decline of the Welfare State: Demography and Globalization,

CESifo Monograph Series, MIT Press.

[8] Simon, Julian L., 1984. "Immigrants, Taxes, and Welfare in the United States," Pop-ulation and Development Review, 10 (March), 55-69.

[9] Sinn, Hans-Werner, forthcoming. "EU Enlargement, Migration and the New Consti-tution." CESifo Economic Studies.

[10] Sinn, Hans-Werner, Gebhard Flaig, Martin Werding, Sonja Munz, Nicola Dull, Her-bert Hofmann, 2001. "“EU Enlargement and Labour Mobility - Consequences for Labour Markets and Redistribution by the State in Germany," CESifo Research Re-port, November, No. 2.

[11] Storesletten, Kjetil, 2000. "Sustaining Fiscal Policy Through Immigration," Journal of Political Economy, Vol. 108 (2), 300-323.

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